Social Security Annual Increase v. Inflation
The announced rate for the 2026 Cost of Living Adjustment (COLA ) for Social Security and Railroad Retirement benefits is 2.80%. The Social Security cost-of-living adjustment (COLA) is based on the average inflation from July, August, and September of the previous year, as measured by the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). This third-quarter average is then compared with the year-earlier third-quarter average to determine the percentage increase for the following January.
The CPI is used as the basis for cost-of-living adjustments for income payments, IRS tax-code adjustments, rental agreements, divorce negotiations, and other critical financial-related transactions. Of course, residing in areas where the cost of just about everything is higher than in most other places can push actual price increases much greater, depending on the inflation-sensitive expenses included in your budget. Even the IRS tax code, for instance, acknowledges the higher per diem rates for specific areas ($225 v. $319).
Taxable Benefits
Either none, some, or a lot of the Social Security Benefit will be taxable. Whether your benefits are taxed and the percentage subject to tax (up to 50% or 85%) depends on your filing status and combined income. If your Federal tax rate is 22%, for instance, the 2.80% COLA could be reduced to a reduced net tax adjustment of 2.28%⁴
⁴ 2.80 – [(2.80 x .85) x .22] see https://www.irs.gov/faqs/social-security-income
Social security attempts to match increased annual expenses with larger yearly benefits. However, the administration’s matching goal is undermined by the inclusion of income taxes on the benefit. In addition, even if the actual increase in the price level was 2.80%, the inclusion of additional sales, excise, and local taxes may further raise prices, while the intended benefit, which increases to match the rise, is whittled down by potential income taxes. Unless the annual cost-of-living adjustments applied to all your income sources are at least an amount that compensates you for the increase in prices of your budgeted living expenses, you will experience a “loss in purchasing power.”
If there was doubt that the inflation rate in the Bay Area should be much higher than in other locations, consider that the median home price in the Bay Area is over $1.4 million, while the national median price is $450,000. Just saying.
If the actual price level in the Bay Area is just 2.0% above the national level, even with higher income benefits, the loss of purchasing power could be startling over the long term. The goods and services you purchase with $100,000 today would only buy 68% of those same goods and services 20 years from now – a 32% loss in purchasing power!
Retirees with future goals may be forced to either voluntarily lower the expected cost of those goals or eliminate them. But if you are committed to attaining future financial goals, the purchasing power loss will be replaced with more-than-expected retirement account withdrawals. Depending on the character of the retirement accounts, additional withdrawals could mean higher taxes, higher Medicare premium thresholds, and the loss of income-limited tax deductions.
As a financial advisor, my focus on helping my clients is addressing what you are trying to accomplish with your investments. With inflation, there are two primary goals:
Hedging inflation: Investors may want to maintain their purchasing power and eliminate the risk of unexpected inflation. For example, people nearing retirement or those with short-term spending needs may be sensitive to changes in inflation. One option is to use Treasury Inflation-Protected Securities (TIPS) or inflation-linked fixed-income strategies, whose returns are adjusted for changes in the CPI. Inflation-hedging assets should move in sync with unexpected inflation.
Outpacing inflation: Growing wealth beyond maintaining purchasing power is the long-term objective for many investors. They can allocate a portion of their portfolio to assets that have historically outpaced inflation. Market history shows that many major asset classes—including stocks and longer-term bonds—have done this. On average, this is true in periods of both lower and higher inflation.
Please consider meeting with me to discuss your financial goals, ideas, and strategies at no charge to you. Feel free to review my website, call me at (925) 484-1671, or email us to schedule an appointment or ask a question.
Anthony Carr, CPA, CFP, MBA
